Recession: avoided or delayed ?

Despite the rise in interest rates in response to the rebound in inflation, the predicted recession is not here. At most, we are seeing a clear slowdown in activity. Has this recession been avoided or has it been postponed, in the dual context of an exit from the crisis and a transition to a new growth regime?

Let’s start with the IMF’s recent assessment of the state of the world economy.

“In the baseline scenario, which assumes that recent financial sector stresses will be contained, growth falls from 3.4 percent in 2022 to 2.8 percent in 2023, before slowly recovering to 3.0 percent within five years, the most pessimistic medium-term forecast in several decades. Advanced countries are expected to experience a particularly sharp slowdown in economic activity, with growth falling from 2.7 percent in 2022 to 1.3 percent in 2023. In another plausible scenario with increased financial sector stress, global growth falls to around 2.5 percent in 2023, the lowest rate since the global economic slowdown in 2001 (excluding the onset of the COVID-19 crisis in 2020 and the period of the global financial crisis in 2009); in the advanced countries, growth falls below 1 percent. This weaker outlook is due to the deployment of stringent measures needed to curb inflation, the impact of the recent deterioration in financial conditions, the continuing war in Ukraine, and increasing geo-economic fragmentation (…). The downside risks to the outlook remain very high and the likelihood of a hard landing has increased sharply. The stresses in the financial sector could amplify and create contagion, weakening the real economy through a sharp deterioration in financing conditions and forcing central banks to reconsider their policies. In a context of rising borrowing costs and slowing growth, over-indebtedness in some countries could spread to a more systemic dimension” 

(IMF, World Economic Outlook, April 2023).(IMF, World Economic Outlook, April 2023).

This state of affairs is reminiscent of the macroeconomic configurations that marked the post-war periods of the last century: the conversion crisis of 1920 followed by an inflationary shock, before the expansion interrupted by the financial crisis of 1929; the jolts of reconstruction after 1945, the return of inflation and macroeconomic instability (inflation rate, growth rate, budget deficits) justifying stop-and-go policies in the United States after 1948 and in Europe in the 1950s.

Coming back to 2023, with this IMF analysis, the stage is set, and all the ingredients of the strong uncertainty weighing on world growth are clearly identified:

• Won’t the rebound in inflation and the rise in interest rates curb aggregate demand and provoke a further downturn in activity? And if the supply shocks that have caused inflation to rise above the former 2% target prove to be lasting, isn’t there a risk that the continuation of restrictive monetary policies will be counterproductive and lead to stagflation?
• Is it appropriate, in the low phase of the cycle, to undertake budgetary consolidation in order to stabilise or even reduce the debt of States?
• Won’t restrictive monetary policies fuel financial instability and weaken both asset markets and banking intermediaries, like the tensions recently observed in the United States and Switzerland, at the risk of triggering a new systemic crisis? and does this not risk triggering sovereign defaults in the many emerging countries that are over–indebted in foreign currencies and subject to rising rates and risk premiums, and thus triggering a new global shock?
• And how, under these conditions, can we initiate and extend on a large scale the transition to a new growth regime respecting the imperative of carbon neutrality and the control of global warming, to which we must now add the policies of rearmament and the new globalisation respecting the requirements of sovereignty and resilience?

There are a thousand ways to analyze these issues, particularly from the point of view of the macroeconomic policies to be implemented, the regulations to be adapted (environmental, prudential, etc.), and the coordination of national responses at the national, European or global level. Each participant in this session, “Recession: avoided or delayed ?”, will be able to choose his or her angle of attack: macroeconomic, financial, microeconomic, industrial, geopolitical, social, historical, etc.

But at the heart of all these challenges, those that threaten short-term growth and raise fears of a new recession, and those on which the post-crisis transition depends, is investment, both public and private. Its level, its sectoral orientation, its location, its short- and medium-term determinants… On the one hand, as a component of aggregate demand and a driving force of the economic cycle in the short and medium term. And, on the other hand, in the longer term, as a key vector of the recomposition of supply in the light of the greening of the economy, digitalization, the extension of a service economy and, from now on, the appropriation of artificial intelligence.

On the government side, there is a considerable need for public investment in energy, housing and transport, as well as in research and training. But in addition to the fall in growth in 2023 and probably again in 2024, is their financing through taxation or borrowing compatible with the continuation of restrictive monetary policies and reminders of the end of whatever it takes and the imperative to reduce public debt?

On the business side, adapting production systems to the environmental and digital revolution requires no less considerable investment. The private sector, in general, has real margins of freedom to finance these investments. Since the end of the COVID crisis and the shock of the war in Ukraine, and despite the return of inflation, profit margins have largely improved and the sharing of added value has not deteriorated to the detriment of companies, unlike in the 1970s at the time of the oil crises. There is no shortage of savings available on the stock or bond markets. But for large companies, the prevailing shareholder logic still leads to large share buybacks or mergers and acquisitions, which reduce productive investment. As for small and medium-sized companies, their investment remains dependent on financing costs, whether from banks or the markets, and they are therefore penalized by high interest rates. Thus, according to the OFCE, after a sharp increase in 2022, the rate of business investment in France will stabilize in 2023, due to the rise in interest rates: +0.1% in the first quarter of 2023 and +0.3% for the following three quarters (OFCE, The Price of Inflation, Prospects for the French Economy in 2023-2024, Policy brief, No. 114, 13 April 2023).

Clearly, for France as for the global economy, only a massive public and private investment shock seems likely to sustain the growth rate at the end of 2023 and in 2024, to avoid any new risk of recession, and to accentuate at the same time a green transition, and thus the major transformation of productive systems that this requires. Is the path taken by governments and central banks, particularly in Europe, the right one? What are the obstacles that could jeopardize this scenario, on the business side? What are the shocks or threats that could thwart it? These are the main questions that participants in the session “Recession: avoided or delayed ?” at the Aix-en-Provence 2023 Economic Forum are invited to answer.